Stephen Bainbridge's Journal of Law, Religion, Politics, and Culture

Economic Analysis Of Law

01/09/2019

Bainbridge, Stephen Mark, The Law and Economics of Insider Trading 2.0. Forthcoming in Encyclopedia of Law and Economics (2nd edition 2020); UCLA School of Law, Law-Econ Research Paper No. 19-01. Available at SSRN: https://ssrn.com/abstract=3312406:

Insider trading is one of the most controversial aspects of securities regulation, even among the law and economics community. One set of scholars favors deregulation of insider trading, allowing corporations to set their own insider trading policies by contract. Another set of law and economics scholars, in contrast, contends that the property right to inside information should be assigned to the corporation and not subject to contractual reassignment. Deregulatory arguments are typically premised on the claims that insider trading promotes market efficiency or that assigning the property right to inside information to managers is an efficient compensation scheme. Public choice analysis is also a staple of the deregulatory literature, arguing that the insider trading prohibition benefits market professionals and managers rather than investors. The argument in favor of regulating insider trading traditionally was based on fairness issues, which predictably have had little traction in the law and economics community. Instead, the economic argument in favor of mandatory insider trading prohibitions has typically rested on some variant of the economics of property rights in information. This is a chapter from the forthcoming Encyclopedia of Law and Economics (2nd edition 2020).

01/04/2019

At the outset, I should observe that I am not an expert in either antitrust or consumer law or economics. But I got to thinking about the problem of time-inconsistent preferences when I read this article in today's WSJ:

Amazon.comInc.AMZN +1.99%is planning to build and expand Whole Foods stores across the U.S., people familiar with the plans said, to put more customers within range of the e-commerce giant’s two-hour delivery service. ...

Amazon offers Prime Now, a two-hour delivery option to members of its Prime subscription service in more than 60 cities, and online grocery pickup from Whole Foods stores in as little as 30 minutes from nearly 30 cities. Amazon plans to expand those services to nearly all of its roughly 475 Whole Foods stores in the U.S., according to another person familiar with the plans. Amazon also wants to use benefits for Prime members to attract new customers to Whole Foods and draw them back more often. ...

The Prime Now service is becoming more popular. Amazon said it delivered more turkeys than ever through Prime Now and the company’s AmazonFresh service this past Thanksgiving, while Whole Foods broke a record for Thanksgiving bird sales. Data firm Numerator found in a recent survey of about 1,200 shoppers that nearly half said they were shopping at Whole Foods more because of Prime promotions.

So here's my concern: I have serious reservations about mega-sized online businesses like Amazon. I discussed one set of my reservations in my essay Corporate Purpose in a Populist Era:

Size and the resulting potential for concentrated economic power are … recurring themes in the populist critique of the corporation. Late 19th Century populists thought that the growing power of corporations was a significant threat to their economic and even political liberty. The Southern Agrarians likewise believed, as Agrarian Lyle Lanier observed, that “the corporate form of our economic system makes possible a scale of exploitation unheard of in history.” In particular, the Agrarians saw large corporations as Leviathans trampling on their employees. The labor such corporations provided lacked security. It was performed under dehumanizing conditions. Yet, the law protected it by enshrining the rights of corporations into the constitution. The Southern Agrarians further believed that the concentration of economic power in large corporations had created “a plutocratic capitalist class” that effectively ruled the country and thus stood ready to fully exploit their power over farmers and workers.

Much the same set of concerns motivates many Tea Party members. In response to the Citizens United decision, for example, Tea Party co-founder Dale Robertson complained that “[c]orporations are not like people. Corporations exist forever, people don’t. Our founding fathers never wanted them; these behemoth organizations that never die. ... It puts the people at a tremendous disadvantage.” Tea Party activists also tend to be uncomfortable with business’ political agenda and business’ lack of support for Tea Party social issues. The inability or unwillingness of large corporations to assist in addressing “the political alienation and economic instability” felt by many gave rise to “both left- and right-wing populism” and helped elect Donald Trump.

For someone like myself who lives somewhat to the right of center, these concerns are compounded by theemergent class of social justice warrior CEOs, whose views on a variety of critical issues are increasingly closer to those of blue state elites than those of red state populists. See generally Joel Kotkin, The New Class Conflict 9-10 (2014) (discussing leftward shift among richest Americans, especially among elites in the financial and tech sectors). A liberaltarian (contrary to what Apple's autocorrect thinks, that's not a typo) like Jeff Bezos definitely raises such concerns. Look at how frequently Amazon has been accusedof abusiveemploymentpractices. And, of course, Amazon wants to use robots and drones to replace people as quickly as possible.

The popular democratic justification for limited liability is rarely observed by modern scholars. Nevertheless, it appears that to the nineteenth-century legislators in states such as New York, who mandated limited liability for corporations' shareholders, the imposition of limited liability was perceived as a means of encouraging the small-scale entrepreneur, and of keeping entry into business markets competitive and democratic. Without limitations on individual shareholder liability, it was believed, only the very wealthiest men, industrial titans such as New York's John Jacob Astor, could possess the privilege of investing in corporations. Without the contributions of investors of moderate means, it was felt, the kind of economic progress states like New York needed would not be achieved.

The author of the most comprehensive study of New York legislative policy toward corporations in the nineteenth century concluded that New York's policy of limited liability, and its policy of encouraging incorporation by persons of modest means "facilitated the growth of a viable urban democracy by allowing a wide participation in businesses that could most advantageously be organized as corporations." "More importantly," he suggested, New York's general incorporation statutes "helped equalize the opportunities to get rich. The passage of general incorporation laws for business corporations was the economic aspect of the political and social forces that democratized the United States during the Age of Jackson, 1825-1855."

Note carefully this line: the "policy of encouraging incorporation by persons of modest means 'facilitated the growth of a viable urban democracy by allowing a wide participation in businesses that could most advantageously be organized as corporations.'" By trampling small businesses underfoot, through its mix of volume pricing and subsidies, Wal-Mart and its ilk undermine the possibility of "wide participation in businesses." Prospective entrepreneurs are thus pushed out of fields like retail.

Of course, maybe Wal-Mart makes up for that by buying products from small entrepreneurs in places like China. But do we really want to encourage our nation’s most likely future superpower rival to further build up its economy with massive trade deficits?

Now what's all that got to do with the problems known to behavioral economists as time inconsistent discount rates and multiple selves.[1]As to the former, the discount rate an individual applies when making net present value calculations often declines as the date of the reward recedes. Korobkin and Ulen offer the following example of this phenomenon, which is known as hyperbolic discounting:

Suppose that an individual is to choose between Project A, which will mature in nine years, and Project B, which will mature in ten years. Suppose, further, that an individual who compares the two projects across all their different dimensions prefers Project B to A. Now suppose that we bring the dates of maturity of the two projects forward while maintaining the one-year difference in their maturity dates. Because discount rates increase as maturity dates get closer, it is possible that the individual’s preference will switch from Project B to Project A as the dates of maturity decline (but preserving the one-year difference).[2]

Richard Thaler offers a more homely explanation of the same phenomenon: “In the morning, when temptation [Project B] is remote, we vow to go to bed early, to stick to our diet, and not have too much to drink [collectively, Project A]. That night we stay out to 3:00 a.m., have two helpings of chocolate decadence, and sample every variety of Aquavit at a Norwegian restaurant.”[3]Put yet another way, one consequence of hyperbolic discounting is that people “always consume more in the present than called for by their previous plans.”[4]In response, the actor may develop a precommitment strategy designed to restrict over time the rate at which the good in question is consumed.

The somewhat related phenomenon of multiple selves posits that individuals do not have a single utility function, but rather multiple competing utility functions. Because each self orders preferences differently, there is an ever-present risk that the self predominating at a given moment may make decisions not in the complete individual’s best interest. Again, Korobkin and Ulen explain: “A stiff tax on cigarettes, to take an obvious example, can be viewed as aiding the future-oriented self in its battle with a more present-oriented self that values immediate gratification over long-term health. . . . Today’s self can attempt to make commitments that either will completely bind tomorrow’s self or, at least, raise the cost of taking action that today’s self wishes to avoid.”[5]In Homer’s tale of Odysseus and the Sirens, Odysseus lashed himself to the mast precisely so that his future self would be unable to satisfy its expected desire to prolong exposure to the Sirens’ song. Being lashed to the mast was a precommitment strategy by which he avoided making an unwise decision in the future. Hence, Odysseus privileged the desires of his farsighted “planner” self, who was concerned with lifetime utility, over those of his myopic and selfish “doer” self.[6]In general, where precommitment strategies are desirable to disempower the myopic “doer” self, “people rationally chose to impose constraints on their own behavior.”[7]

Amazon poses a problem for me not unlike the one the Sirens posed for Odysseus. In theory, I would prefer to shop at local stores selling locally-sourced products. (See Rod Dreher's Crunchy Cons for an explanation of why conservatives like Rod and myself can have preferences usually associated with Birkenstock wearing Berkley-based SJWs.)

In practice, Amazon makes it so easy to translate desire into nearly-instant gratification, I am constantly choosing to punch a few buttons and wait for the doorbell to ring. Smartphones and tablets have made it even worse. My doer self consistently trumps my planner self.

Now suppose there is general agreement that Amazon's incipient monopolization of retailing is socially undesirable, but each of us as individuals inevitably succumb to the beguiling temptations of immediate gratification. Now we have a serious public policy issue. We would all be better off if we could precommit to shopping elsewhere. Yet, we all will inevitably choose to free ride on others. The benefits of shopping with Amazon are immediate and obvious, while the costs are longterm and diffuse. So we choose to tell Alexa what we want and hope somebody else bears the costs of constraining Amazon's growth. As a result, nobody boycotts Amazon and it just gets bigger and more powerful.

Amazon thus looks like a case study of the need for what Class Sunstein and Richard Thaler call "libertarian paternalism." In their book Nudge, they propose that the law "nudge" decisions in certain directions by imposing both procedural and substantive constraints that limit the available choice set to those that are social welfare maximizing.

Before the government starts nudging us into shopping at the local Farmer's Market instead of AmazonFresh, however, a few caveats are in order. First, we need more information about the cost-benefit analysis. So far the case that Amazon's continuing growth is socially undesirable is based mostly on anecdote rather than data. Second, even if government regulation benefits most consumers, inevitably there will be some who are worse off. Creating space for privately-initiated precommitments enforced by social norms would be less infringing on liberty. Finally, of course, regulators are never disinterested observers, but rather self-interested actors who se output therefore may not be socially optimal.

At least in the United States, the government has watched benevolently Amazon relentlessly pursues market share at the expense of revenue, which would strike some as the sort of behavior one expects from an aspiring monopolist. Likewise, Amazon has bought out potential competitors rather than allowing them to grow into serious challengers. Amazon's employment practices are suspect, at best, but have drawn little more than media disapprobation.

The time for letting Amazon slide by with little scrutiny is over. The time for letting government nudge us into new shopping patterns may well be coming.

08/03/2018

We all know I'm a skeptic of empirical analysis, so let's take this with a grain of salt, but it still seems interesting:

I find evidence that shareholders prefer political connectedness to corporate social responsibility (CSR). Choosing political connectedness with President Trump over CSR causes shareholder value to increase by $345 million per firm, on average. However, choosing CSR over political connectedness with Trump causes shareholders to lose $570 million on average, and as much as $1.8 billion, per firm. These results reveal an asymmetric response to the choice between political connectedness and CSR and support the view that CSR is an agency problem. Spillover also exists, as rival firms typically incur wealth gains (losses) when main firms choose political connectedness (CSR).

03/26/2018

Why does the law provide so many different types of business entities? When I tackle that question in class, I start with a homely example:

The job-interviewing season will soon be upon my students when Business Associations is taught in the fall. Odds are some of them therefore went out and bought a suit this summer. What were their options were when they bought a suit. The correct answers are: Go to a store and buy one off the rack or have one custom made. Most, if not all, will have bought the off the rack suit. Why?

The off the rack suit is cheaper but will not fit as well. The custom-made suit is much more expensive but fits real well. The problem with custom made suits is that you need to go to a very good tailor and spend a lot of time on fittings. If you’re like most people you will probably buy one off the rack; you either can’t afford a custom made suit or the expense isn’t worth the marginal extra fit. To solve the problem of not having a very good fit from the off the rack suit, the student spent a little extra money to get a better fit by having it altered.

The analogy: Setting up a business is just like buying a suit off the rack: By providing a set of standardized—off-the-rack—rules, the state saves the parties from having to invest time and effort in bargaining and money in the form of legal and other costs.

This is a very important point. It is a fundamental offshoot of the core insight that the firm is not a thing, but rather a nexus of contracts. See Stephen M. Bainbridge, Contractarianism in the Business Associations Classroom, 34 Geo. L. Rev. 631 (2000). If you think about it for a minute, it should be fairly obvious that firms (such as corporations) are really just a set of contracts between various constituencies of the organiza­tion. For example, the relationship between a manager and the firm is based on an employment contract. If manager A doesn’t want to obey a superior’s command, he doesn’t have to, although that may be a breach of contract. Similarly, the relationship between creditors and the firm is based on the credit agreement. And so forth. To be sure, many of these contracts are implicit, but they are nonetheless contractual.

The nexus of contracts model implies that corporate law is properly viewed as a standardized contract which the firm’s constituencies adopt.

The Rent-a-Car Analogy: Most students have probably rented a car at some point in your life. I ask: What happened when you met with the agent? Did you negotiate a deal that one of you then recorded in writing? No. Of course not. You used a standardized pre-printed contract. Did you do any bargaining? It would not be surprising if there was a limited array of options you were offered on a take-it-or-leave-it basis; usually, insurance coverage is one. So there may have been some slight modifications to the contract. I want students to think of corporate law as though it were the car rental contract. Just as the contract offered them a set of standardized rules to govern the rental relationship, corporate law offers the constituencies of a corporation a set of rules to govern their relation­ship.

In many cases, the parties probably will not have a detailed written agreement, which is acceptable if it would be expensive for them to take the time to negotiate a comprehensive set of specialized terms and for each to hire a lawyer to protect their own interests. Those costs are likely to be significant. The benefits of a specialized contract, in contrast, are likely to be small in many settings. The standard agency rules should be pretty much satisfactory. So organization law ends up saving them bargaining costs by giving them an off the rack legal relationship which is more or less ready to go.

In some situations, however, it may be much more desirable to have a written contract setting forth detailed terms. Suppose Mary is being hired as a CEO. In that case, the standard form contract provided by agency law is not likely to be satisfactory. A great deal of money is involved and the job is highly specialized. These factors probably make it worthwhile to engage in extensive negotiations and (here’s the good news) to hire a battery of lawyers.

We are tailors. Our task as lawyers in large part is to know the common-law and statutory rules—the bargain implied in the absence of a contrary agreement between the parties—and to appreciate when and how it is appropriate to try to modify that standard form contract. We also of course need to know which of the rules are mandatory, which cannot be altered even if everyone agrees to do so. In that case our job is often finding a way around the mandatory rules or helping our clients to live with them.

What's all that got to do with the multiple forms of business organizations?

Investors are heterogeneous and the best approach may be to offer them standard form contracts--off the rack rules--that provide significant choice. Corporate, LLC, and partnership law therefore should differ in many respects. Society then will maximize investor welfare by letting investors choose the form best suited to their business.

To continue the analogy, we don't tell somebody going out to buy a suit that one size fits all. Instead, we recognize that that's just not true. So we give our suit buyer an array of choices in terms of sizes and fits. If we only offered one size, some people would never find a suit that fits (trust me on that one) or they'll spend an unnecessary fortune on tailoring alterations.

Just so with having multiple entities. If the rules of the various entities differ, we can pick the entity that is closest to what the client needs and set it up with minimal bargaining costs or lawyer fees. If all the entities have basically the same rules, however, we end up forcing clients to bargain over departures from the standard form and expend legal costs having their bargain turned into workable contracts.

And that is just what the Uniform Law Commissioner's moronic harmonization project did. That project was intended to “harmonize nine separate uniform acts dealing with business entities.” Daniel S. Kleinberger, Protecting the Deal: Enforcing and Protecting the Owners' Agreement, Bus. L. Today, April 2015, at 1. “Due to the Harmonization Project, most provisions in these three acts now use essentially identical wording.” Id. As a result, in many cases, it is no longer possible to achieve differing outcomes for one’s clients simply by picking the appropriate business entity form.

I realize the harmonization project was finished in 2013. One of my regrets is that I didn't write about it before it was finished. But I've spent a good chunk of this spring updating my agency and partnership casebook and my agency and partnership treatise. When I finished working on the relevant section of the treatise today, I just needed to vent. And isn't that what having a blog is for?

01/23/2018

I'm dubious of empirical analyses (except when they confirm my preexisting priors, of course), but I nevertheless found Michael Klausner's overview very helpful and provocative:

This chapter examines the empirical literature on corporate law and governance in the United States. Four areas of the US corporate governance literature are discussed: (i) state competition to produce corporate law, (ii) independent boards, (iii) takeover defenses, and (iv) the use of corporate governance indices. The chapter concludes that these areas of research reflect varying degrees of success. The literature on state competition has been a major success. We know much more in this area as a result of empirical analysis in this area than we did on the basis of theory alone. At the other extreme is the literature on takeover defenses and the related literature that uses governance indices as measures of governance quality. Those empirical literatures are plagued by misunderstandings of how takeovers and takeover defenses work, and many results are therefore not as informative as they appear to be. In between is the literature on the impact of an independent board. Here, empiricists faced perhaps insurmountable challenges in proving causation, but nonetheless exposed informative associations.

Klausner, Michael, Empirical Studies of Corporate Law and Governance: Some Steps Forward and Some Steps Not (January 2018). Forthcoming Chapter of Oxford Handbook on Corporate Law and Governance (2018); European Corporate Governance Institute (ECGI) - Law Working Paper No. 381/2018. Available at SSRN: https://ssrn.com/abstract=3097568

On its surface, Jesus’ Parable of the Talents is a simple story with four key plot elements: (1) A master is leaving on a long trip and entrusts substantial assets to three servants to manage during his absence. (2) Two of the servants invested the assets profitably, earning substantial returns, but a third servant — frightened of his master’s reputation as a hard taskmaster — put the money away for safekeeping and failed even to earn interest on it. (3) The master returns and demands an accounting from the servants. (4) The two servants who invested wisely were rewarded, but the servant who failed to do so is punished.

Neither the master nor any of the servants make any appeal to legal standards, but it seems improbable that there was no background set of rules against which the story plays out. To the legal mind, the Parable thus raises some interesting questions: What was the relationship between the master and the servant? What were the servants’ duties? How do the likely answers to those questions map to modern relations, such as those of principal and agent? Curiously, however, there are almost no detailed analyses of these questions in Anglo-American legal scholarship.

This project seeks to fill that gap.

I recently ran across a very interesting homily on the parable by Bishop Robert, which naturally puts a more theological spin on the parable, which I highly commend to your attention:

11/06/2017

Dorff rightly concludes from a lengthy analysis of both empirical evidence and laboratory studies of decision making, “performance pay very likely … does not result in better performance.”

As I likewise observed in a Texas Law Review article reviewing Bebchuk & Fried’s book, there is relatively little evidence that CEOs are motivated by pay, which suggests the possibility that CEOs are motivated principally by other concerns such as ego, reputation, and social effort norms. Put another way, the latter considerations may be the principal mechanisms by which the principal-agent problem is resolved. If so, evidence advanced by either side to show that incentive compensation either does or does not improve performance tells us nothing other than that researchers have mined the data to find a spurious correlation. Worse yet, at least from the perspective of those who wish to use compensation to address the principal-agent problem, the goal of linking pay and performance inevitably will prove an exercise in futility. ...

As Dorff points out, although CEO pay had been growing fast relative to other metrics during the 1980s, it was in the 1990s that CEO pay really started to explode as a percentage of corporate profits and total wages. In large measure, this occurred because of a huge shift towards options and other forms of incentive pay that were tax favored under the 1993 amendments.

Despite this temporal correlation, Dorff downplays the role that regulation in general and § 162(m) play in our story.

In contrast, I think it was a pivotal moment. As former SEC Chairman Christopher Cox noted, it deserves a “place in the museum of unintended consequences.”

It’s not just that § 162(m) created tax incentives for using performance pay schemes. I believe § 162(m) is a prime example of how law, by expressing social values, can change social norms or even create new norms. ...

CEO pay thus is an artifact of neither managerial power nor arms-length bargaining. Instead, its current structure and size is a product of a paradigm shift that has become deeply embedded in the social norms that regulate boardroom decision making. Which explains why boards refused to “reverse course.”

Regulation played a critical—albeit unintended—role in this process by validating the emergent norm and giving it a seal of approval not just from leading theorists but also the Congress and President of the United States. ...

Mr Dorff believes that performance-related pay should be scrapped and managers paid a salary. This would be good for shareholders: the pay revolution has dramatically increased the proportion of profits that go to the CEOs. It would be good for the country because it would reduce the likelihood of future Enrons or Lehman Brothers. It would even be good for CEOs who would have a guaranteed income.

Which brings me to the GOP tax plan. Bloomberg reports that:

Under current law, businesses can write off as much as $1 million in compensation expenses for chief executive officers and four other top-paid bosses, plus any amount beyond that if it's tied to performance targets. The Republican proposal unveiled Nov. 2 would keep the $1 million threshold but eliminate the exemption for pay linked to results, denying companies the option to write off large equity awards.

This is not my preferred solution. As I argued back in 2014:

I think the solution is a massive deregulation of CEO pay. Eliminate all tax rules that penalize some pay formats and all rules that subsidize others. Eliminate say on pay, the Section 16(b) exemptions for incentive pay, and so on. Leave in place only simple, clear disclosure rules (with no nonsense about CEO-worker pay ratios or what have you), and let sunlight be your disinfectant and electric light your policeman.

I’m not taking a position over whether these executives did the right or the wrong thing in each instance, but I am concerned that when CEOs simultaneously run their companies and run for president, it’s difficult to discern whether their political moves are intended to benefit the corporation (including, as relevant, all stakeholders), or their own political careers. Under these conditions, how can shareholders be certain that their CEOs’ actions – on everything from labor conditions to executive pay to environmental footprints – are intended to advance the best interests of the company?

Personally, I don't think this will keep me up at night. After all, unlike some especially pernicious ways in which CEOs misbehave, this one takes place in full public view. And, of course, it's not going to be a very common problem. Still, the conflicts inherent in a CEO running for POTUS probably justify boards asking the CEO to step down.

07/31/2017

What is the appropriate objective function for a firm? We analyze this question for the case where shareholders are prosocial and externalities are not perfectly separable from production decisions. We argue that maximization of shareholder welfare is not the same as maximization of market value. We propose that company and asset managers should pursue policies consistent with the preferences of their investors. Voting by shareholders on corporate policy is one way to achieve this.

It is clearly not the law that company managers must "pursue policies consistent with the preferences of their investors."

The value of a shareholder's investment, over time, rises or falls chiefly because of the skill, judgment and perhaps luck-for it is present in all human affairs-of the management and directors of the enterprise. When they exercise sound or brilliant judgment, shareholders are likely to profit; when they fail to do so, share values likely will fail to appreciate. In either event, the financial vitality of the corporation and the value of the company's shares is in the hands of the directors and managers of the firm. The corporation law does not operate on the theory that directors, in exercising their powers to manage the firm, are obligated to follow the wishes of a majority of shares. In fact, directors, not shareholders, are charged with the duty to manage the firm.

Why is that the default rule rather than the one proposed by Hart and Zingales? Hart and Zingales discuss many of the standard tropes, many of which have been neaten to death on these pages and elsewhere. So let's take a different approach.

Let's start with the assumption that the current legal rule is the majoritarian default. Why?

I suspect it's less costly for firms to shareholders to learn about firm policies than for firms to try to gather information about shareholder preferences.

Public companies exist in a fluid and constantly changing market. This is presumably one reason, for example, that shareholders get a say on pay every year (or two): As shareholder demographics shift, so may their preferences. Hart and Zingales' proposal thus would only work if shareholder preferences are stable and homogenous. Neither seems likely to be true, as my friend and colleague Iman Anabtawi has pointed out. Indeed, shareholder policy preferences can shift very rapidly when activist shareholders arrive on scene and demand sweeping changes in core policies.

Let's think of the stock market as a cafeteria. The investor can move down the line, selecting those companies that match their preferences and declining those that don't.

It's well known, of course, that it's hard to publish studies that find no result.

But I wonder to whether there isn't a political bias here. Given the substantial tilt to the left in academia, one suspects that a lot of these number crunchers go into the problem with a preconceived notion of the "right" result and mine their data until they find one. One also suspects that editors of journals, sharing those same biases, are more likely to publish results that confirm their own policy preferences.

A recent CLS blog post by Martijn Cremers, Saura Masconale and Simone M. Sepe illustrates a recurring problem with empirical legal scholarship: First, it can only provide answers if the question involves something you can count. Second, how you count that something maters a lot.

In the past 20 years, many corporate law scholars have come to the view that governance arrangements protecting incumbents from removal are what really matter for firm value, arguing that such arrangements help entrench managers and harm shareholders. A major factor supporting this view has been the rise of empirical studies using corporate governance indices to measure a firm’s governance quality. Providing seemingly objective evidence that protecting incumbents from removal reduces firm value, these studies have encouraged the idea that good corporate governance is equivalent to stronger shareholder rights.

In our recent article, we challenge this idea, presenting new empirical evidence that calls into question prior studies that rely on corporate governance indices and developing a novel theoretical account of what really matters in corporate governance.

In revisiting the results of these studies, we focus on the entrenchment index or E-Index, introduced in 2009 by Lucian Bebchuk, Alma Cohen, and Allen Ferrell (BCF). The E-Index provides evidence that six entrenchment provisions matter the most for firm value: staggered boards, poison pills, golden parachutes, supermajority requirements for charter amendments, supermajority requirements for bylaw amendments, and supermajority requirements for mergers. As of March 2017, over 300 empirical studies have used the E-Index as a measure of governance quality, suggesting that this index has become a standard reference to define entrenchment and, hence, “bad” governance. Yet, in estimating the association between the E-Index (and each of its six constituent components) and firm value, BCF only relied on a 12-year period (from 1990 to 2002). We rely on a much more comprehensive dataset over a much longer period (from 1978 to 2008), allowing for a more robust statistical analysis of the association between corporate governance and firm value.

Our empirical findings call into question the kitchen sink approach to incumbent protection from removal adopted by the E-index.

But doesn't it also call into question the whole exercise? What if a data set running from 1960 to 2010 produced still different results? Bah, humbug.

On its surface, Jesus’ Parable of the Talents is a simple story with four key plot elements: (1) A master is leaving on a long trip and entrusts substantial assets to three servants to manage during his absence. (2) Two of the servants invested the assets profitably, earning substantial returns, but a third servant — frightened of his master’s reputation as a hard taskmaster — put the money away for safekeeping and failed even to earn interest on it. (3) The master returns and demands an accounting from the servants. (4) The two servants who invested wisely were rewarded, but the servant who failed to do so is punished.

Neither the master nor any of the servants make any appeal to legal standards, but it seems improbable that there was no background set of rules against which the story plays out. To the legal mind, the Parable thus raises some interesting questions: What was the relationship between the master and the servant? What were the servants’ duties? How do the likely answers to those questions map to modern relations, such as those of principal and agent? Curiously, however, there are almost no detailed analyses of these questions in Anglo-American legal scholarship.

This project seeks to fill that gap.

Bainbridge, Stephen M., The Parable of the Talents (August 15, 2016). UCLA School of Law, Law-Econ Research Paper No. 16-10. Available at SSRN: https://ssrn.com/abstract=2787452

03/03/2017

I really like this new paper by Steven Davidoff Solomon and David Zaring:

The Trump administration has promised to pursue policy through deals with the private sector, not as an extraordinary response to extraordinary events, but as part and parcel of the ordinary work of government. Jobs would be onshored through a series of deals with employers. Infrastructure would be built through joint ventures where the government would fund but private parties would own and operate public assets.

We evaluate how this dealmaking state would work as a matter of law. Deals were the principal government response to the financial crisis, partly because they offered a just barely legal way around constitutional and administrative barriers to executive action. Moreover, unilateral presidential dealmaking epitomizes the presidentialism celebrated by Justice Elena Kagan, among others. But because it risks dispensing with process, and empowers the executive, we identify ways that it can be controlled through principles of transparency, rules of statutory interpretation, and policymaking best practices such as delay and equivalent treatment of similarly situated private parties.

Davidoff Solomon, Steven and Zaring, David T., The Dealmaking State: Executive Power in the Trump Administration (February 21, 2017). Available at SSRN: https://ssrn.com/abstract=2921407